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CONTEMPORARY ISSUE ON SEMINAR
         A STUDY ON



 “Current scenario of Venture Capital”




                       www.studygalaxy.com

                                         1
Preface

The underlying aim of the seminar on contemporary issue as an
integral part of MBA program is to provide the students with practical
aspects of the organization – working environment.
Such type of presentation helps a student to visualize and realize
about the congruencies between the theoretical learning in the
premises of college and actual followed by the organization. It gives
the knowledge of application aspect of the theories learnt in the
classroom.
The seminar project in “Current scenario of Venture capital” is a
complete experience in itself, which provide me with the
understanding. This has become as inspirable of my knowledge of
management being learned in MBA program.




                                                                     2
INDEX

1.Introduction
2.Concept of venture capital
3.History
4.Role within venture capital firm
5.Key factor of venture capital
6.Advantages of venture capital
7.Method of venture capital financing
8.Process of venture capital
9.Venture capital scenario of India
10. Sector of Interested
11. Webliography / bibliography




                                        3
I.      INTRODUCTION




VENTURE:

   A business project or activity specially one that involves risk.


CAPITAL:

   Fund employed in any business activity.
   Most important factor of production.
   No economic entity can function without capital.

VENTURE CAPITAL:

    Venture capital is a type of private equity capital typically provided by
professional, outside investors to new, growth businesses




VENTURE CAPITALISTS:

                                                                           4
A venture capitalist (VC) is a person who makes such investments,
these include wealthy investors, investment banks, other financial
institutions other partnerships.

CONCEPT:




 vvvv VENTURE                                              VENTURE
                                 VENTURE
      CAPITAL                                              CAPITAL
                                 CAPITAL
      Drives new                                       Is risky but creates
                            People oriented
      industries                                       wealth.
                            Growth oriented
                            Exit oriented
                            Internationally
                            oriented




    Venture capital is a means of financing fast-growing private companies.
Finance may be required for:
   The start up,
   Development/ expansion, &
   Modernization
 Of a company. Growing businesses always require capital. There are a
number of different ways to fund growth.

       These include the owner's own capital, arranging debt finance or
seeking an equity partner, as is the case with venture capital.
With venture capital, the venture capitalist acquires an agreed proportion of


                                                                              5
the equity of the company in return for the requisite funding. Equity finance
offers the significant advantage of having no interest charges. It is patient
capital that seeks a return through long-term capital gain rather than
immediate          and       regular        interest        payments.

      Venture capital investors are exposed, therefore, to the risk of the
company failing. As a result the venture capitalist have to invest in
companies that have the ability to grow very successfully and give higher-
than-average returns to compensate for the risk.

      Venture Capital may be a viable source of financing for a business.
While they generally invest in businesses that are more established and
ongoing, some do fund start-ups. In general they tend to invest in high-
technology businesses such as research and development, electronics and
computers. Venture Capitalists deal more in large sums of money,
numbering into the millions of dollars, so they are generally well suited to
businesses that are going grand from the start or have grown and require
gigantic expansion


TASKS OF VENTURE CAPITALISTS:

When venture capitalists invest in a business they :

                • Become part-owners and typically require a seat on the
                  company's board of directors.

                • They tend to take a minority share in the company and
                  usually do not take day-to-day control.

                • Professional venture capitalists act as mentors and aim to
                  provide support and advice on a range of management
                  and technical issues.

                • Assist the company to develop its full potential.
                  The management support is the most important
                  contribution of a venture capitalist. There are many


                                                                            6
sources of capital, but only a venture capitalist can
provide experienced management input gained by
helping many other companies successfully conquer the
inevitable problems and growing pains.




                                                    7
HISTORY




Beginnings of modern venture capital:
    The earliest origins of venture capital can be traced back to the medieval
Islamic mudaraba partnership. In terms of protecting the entrepreneur,
sharing the risks, losses and profits the two systems of finance are
remarkably similar.

     General Georges Doriot is considered to be the father of the modern
venture capital industry.

                • In 1946, Doriot co-founded American Research and
                  Development Corporation (AR&DC) with Ralph
                  Flanders, Karl Compton and others, the biggest success
                  of which was Digital Equipment Corporation.


                                                                             8
• When Digital Equipment went public in 1968 it provided
                 AR&DC with 101% annualized Return on Investment
                 (ROI). AR&DC’s $70,000 USD investment in Digital
                 Corporation in 1957 grew in value to $355 million USD.
               • It is commonly accepted that the first venture-backed
                 startup is Fairchild Semiconductor, funded in 1959 by
                 Venrock Associates. Venture capital investments, before
                 World War II, were primarily the sphere of influence of
                 wealthy individuals and families.
               • Small Business Administration 1958. One of the first
                 steps toward a professionally-managed venture capital
                 industry was the passage of the Small Business
                 Investment Act of 1958. The 1958 Act officially allowed
                 the U.S. Small Business Administration (SBA) to license
                 private "Small Business Investment Companies" (SBICs)
                 to help the financing and management of the small
                 entrepreneurial businesses in the United States. Passage
                 of the Act addressed concerns raised in a Federal Reserve
                 Board report to Congress that concluded that a major gap
                 existed in the capital markets for long-term funding for
                 growth-oriented small businesses. Facilitating the flow of
                 capital through the economy up to the pioneering small
                 concerns in order to stimulate the U.S. economy was and
                 still is the main goal of the SBIC program today.

       Generally, venture capital is closely associated with technologically
innovative ventures and mostly in the United States. Due to structural
restrictions imposed on American banks in the 1930s there was no private
merchant banking industry in the United States, a situation that was quite
exceptional in developed nations.

      As late as the 1980s Lester Thurow, a noted economist, decried the
inability of the USA's financial regulation framework to support any
merchant bank other than one that is run by the United States Congress in
the form of federally funded projects. These, he argued, were massive in
scale, but also politically motivated, too focused on defense, housing and


                                                                          9
such specialized technologies as space exploration, agriculture, and
aerospace.

          US investment banks were confined to handling large M&A
transactions, the issue of equity and debt securities, and, often, the breakup
of industrial concerns to access their pension fund surplus or sell off
infrastructural capital for big gains.

    Not only was the lax regulation of this situation very heavily criticized at
the time, this industrial policy differed from that of other industrialized
rivals—notably Germany and Japan—which at that time were gaining
ground in automotive and consumer electronics markets globally. However,
those nations were also becoming somewhat more dependent on central
bank and elite academic judgment, rather than the more diffuse way that
priorities were set by government and private investors in the United States.




                                                                             10
THE GROWTH OF SILICON VALLEY




Slow Growth in 1960s & early 1970s, and the First Boom Year in 1978:

        During the 1960s and 1970s, venture capital firms focused their
investment activity primarily on starting and expanding companies. More
often than not, these companies were exploiting breakthroughs in electronic,
medical or data-processing technology. As a result, venture capital came to
be almost synonymous with technology finance.

     Venture capital firms suffered a temporary downturn in 1974, when the
stock market crashed and investors were naturally wary of this new kind of
investment fund.1978 was the first big year for venture capital. The industry
raised approximately $750,000 in 1978.



                                                                          11
Highs & Lows of the 1980s:

     In 1978, the US Labor Department reinterpreted ERISA legislation and
thus enabled this major pool of pension fund money to invest in alternative
assets classes such as venture capital firms. Venture capital financing took
off.

     1983 was the boom year - the stock market went through the roof and
there were over 100 initial public offerings for the first time in U.S. history.
That year was also the year that many of today's largest and most prominent
VC firms were founded.

     Due to the excess of IPOs and the inexperience of many venture capital
fund managers, VC returns were very low through the 1980s. VC firms
retrenched, working hard to make their portfolio companies successful. The
work paid off and returns began climbing back up.

The dot com boom:

    The late 1990s were a boom time for the globally-renowned VC firms on
Sand Hill Road in the San Francisco Bay Area. A number of large IPOs had
taken place, and access to "friends and family" shares was becoming a major
determiner of who would benefit from any such Common investors would
have had no chance to invest at the strike price in this stage.

    The NASDAQ crash and technology slump that started in March 2000
shook some VC funds significantly by the resulting disastrous losses from
overvalued and non-performing startups.

    By 2003 many firms were forced to write off companies they had funded
just a few years earlier, and many funds were found "under water";( the
market value of their portfolio companies were less than the invested value).
Venture capital investors sought to reduce the large commitments they had
made to venture capital funds. By mid-2003, the venture capital industry
would shrivel to about half its 2001 capacity.

      Nevertheless, PricewaterhouseCoopers' MoneyTree Survey shows that
total venture capital investments hold steady at 2003 levels through the
second quarter of 2005. The revival of an Internet-driven environment


                                                                             12
(thanks to deals such as eBay's purchase of Skype, the News Corporation's
purchase of MySpace.com, and the very successful Google.com and
Salesforce.com IPOs) have helped to revive the VC environment.




ROLES WITHIN A VENTURE CAPITAL FIRM


1. Venture capital general partners: (Also known in this case as "venture
capitalists" or "VCs") are the executives in the firm. In other words the
investment professionals. Typical career backgrounds vary, but VCs come
from either an operational or a finance background.

         VCs with an operational background tend to be former chief
executives at firms similar to those which the partnership finances and other
senior executives in technology companies.VCs with finance backgrounds
come from investment banks, M&A firms, and other firms in the corporate
investment and finance space.

2. Limited partners: Investors in venture capital funds are known as limited
partners. This constituency comprises both high net worth individuals and
institutions with large amounts of available capital, such as state and private
pension funds,       insurance companies, and pooled investment vehicles,
called fund of funds or mutual funds.

3. Venture partners and entrepreneur-in-residence (EIR): Other
positions at venture capital firms include venture partners and
entrepreneur-in-residence (EIR).Venture partners "bring in deals" and
receive income only on deals they work on (as opposed to general partners
who receive income on all deals).

     EIRs are experts in a particular domain and perform due diligence on
potential deals. EIRs are engaged by VC firms temporarily (six to 18
months) and are expected to develop and pitch startup ideas to their host
firm (although neither party is bound to work with each other). Some EIR's


                                                                            13
move on to roles such as Chief Technology Officer (CTO) at a portfolio
company.

                 4. Associate: The "associate" is the typical apprentice
                    within a venture capital firm. After a few successful
                    years, an associate may move up to the "senior
                    associate" position. The next step from senior
                    associate is "principal," typically a partner track
                    position. Alternatively, there are many pre-MBA
                    associate roles that are used solely for the purpose of
                    deal sourcing, and the associate is usually expected to
                    move on after two years.



                        STRATEGIC ROLES
               Serving Board
               Business Consultant
               Financier




                     SOCIAL/ SUPPORTIVE
                       • Coach/ Mentor
                       • Conflict resolver




.

                     NETWORKING ROLES
                   • Management recruiter
                   • Professional contact
                   • Industrial contact



                                                                        14
FEATURES OF VENTURE CAPITAL
The main features of venture capital are:

Long-time horizon: In general, venture capital undertakings take a longer
time — say, 5-10 years at a minimum — to come out commercially
successful; one should, thus, be able to wait patiently for the outcome of the
venture.

Lack of liquidity: Since the project is expected to run at start-up stage for
several years, liquidity may be a greater problem.

High risk: The risk of the project is associated with management, product
and operations.

    Unlike other projects, the ones that run under the venture finance may be
subject to a higher degree of risk, as their result is uncertain or, at best,
probable in nature.

High-tech: Venture capital finance caters largely to the needs of first-
generation entrepreneurs who are technocrats, with innovative technological
business ideas that have not so far been tapped in the industrial field.

    However, a venture capitalist looks not only for high-technology but the
innovativeness through which the project can succeed.

Equity participation and capital gains: A venture capitalist invests his
money in terms of equity or quasi-equity. He does not look for any dividend
or other benefits, but when the project commercially succeeds, then he can

                                                                           15
enjoy the capital gain which is his main benefit. Otherwise, he will be losing
his entire investment.

Participation in management: Unlike the traditional financier or banker,
the venture capitalist can provide managerial expertise to entrepreneurs
besides money.

    Since many innovations and inventions cannot be commercialized due to
lack of finance, venture capital finance acts as a strong impetus for
entrepreneurs to develop products involving newer technologies and to
commercialize them.

     Venture capital has also gained in importance as a mechanism for the
rehabilitation of sick companies. Moreover, venture capitalists also assist
smaller units in upgrading their technology.




KEY FACTORS FOR THE SUCCESS:
The key factors for the success of any project under the consideration of a
venture capitalist are:

                • Clear and objective thinking;
                • Operational experience, especially in a start-up;
                • Firm grasp of numbers of numbers;
                • People management skills;
                • Ability to spot technology and market trends;
                • Wide network of contacts;
                • Knowledge of all facets of business — marketing,
                  Finance and HR;
                • Judgment to evaluate them on the basis of integrity and
                  ability;
                • Patience to pursue the final goal;
                • Drive to guide budding entrepreneurs; and


                                                                            16
• Empathy with entrepreneurs.




                                           PATIENCE
              CLEAR
              OBJECTIVE




NETWORK                  SUCCESS                EXPERIE
                                                NCE


                 DRIVE                    MANAGEME
                                          NT SKILLS




                                                          17
ADVANTAGES OF VENTURE CAPITAL
        Venture capital has made significant contribution to technological
innovations and promotion of entrepreneurism. Many of the companies like
Apple, Lotus, Intel, Micro etc. have emerged from small business set up by
people with ideas but no financial resources and supported by venture
capital. There are abundant benefits to economy, investors and entrepreneurs
provided by venture capital.

Economy Oriented-
             • Helps in industrialization of the country
             • Helps in the technological development of the country
             • Generates employment
             • Helps in developing entrepreneurial skills

Investor oriented-
                • Benefit to the investor is that they are invited to invest
                   only after company starts earning profit, so the risk is less
                   and healthy growth of capital market is entrusted.
                • Profit to venture capital companies.
                • Helps them to employ their idle funds into productive
                   avenues.

Entrepreneur oriented:
              • Finance - The venture capitalist injects long-term equity
                 finance, which provides a solid capital base for future
                 growth. The venture capitalist may also be capable of
                 providing additional rounds of funding should it be
                 required to finance growth.


                                                                             18
• Business Partner - The venture capitalist is a business
          partner, sharing the risks and rewards. Venture capitalists
          are rewarded by business success and the capital gain.
        • Mentoring - The venture capitalist is able to provide
          strategic, operational and financial advice to the company
          based on past experience with other companies in similar
          situations.
        • Alliances - The venture capitalist also has a network of
          contacts in many areas that can add value to the
          company, such as in recruiting key personnel, providing
          contacts in international markets, introductions to
          strategic partners and, if needed, co-investments with
          other venture capital firms when additional rounds of
          financing are required.
        • Facilitation of Exit - The venture capitalist is experienced
          in the process of preparing a company for an initial
          public offering (IPO) and facilitating in trade sales.



                         ADVANTAGES




ENTREPRENEUR              ECONOMY                     INVESTOR
                          ORIENTED




                                                                   19
WHAT DO VENTURE                CAPITALISTS        LOOK      FOR     WHILE
INVESTING?

1. A GROWING MARKET: The venture capitalists see whether the
company is targeting a substantial and rapidly growing market. Does the
company have a reasonable chance to successfully enter the market and
obtain a strong market position?

2. A UNIQUE PRODUCT: Is the company having a proprietary or
differentiated product? Does the product offer benefits over existing
products? Does it have patent or other proprietary protection to forestall
competitors?

3. IPO CANDIDATE OR ACQUISITION TARGET: Whether the company
has the possibility of growing quickly and becoming an attractive acquisition
target or IPO candidate? Venture capitalists are concerned about how they
will realize liquidity and receive value for their investment.

4. SOUND BUSINESS PLAN: Is the company's strategy and business plan
sound? Venture capitalists expect to see a well-thought-out, coherent
business plan.

5. SIGNIFICANT GROSS PROFIT MARGINS: Can the product or service
generate significant gross profit margins (40 percent or more)? Large profit
margins give a company room for error and enhance its attractiveness for a
possible IPO or acquisition.

6. HOME RUN POTENTIAL: Finally, the venture capitalist wants to see
the possibility of hitting a "home run" by investing in the company. Most


                                                                          20
venture capitalists won't be interested unless the company can grow to at
least $25 million in sales within five years.

.




             METHODS OF VENTURE FINANCING
     A pre-requisite for the development of an active venture capital industry
is the availability of a variety of financial instruments which cater to the
different risk-return needs of investors. They should be acceptable to
entrepreneurs as well.

Venture capital financing in India took four forms:-
                • Equity
                • Conditional Loan
                • Convertible Debentures
                • Cumulative Convertible Preference Share

Equity:-

    All VCFs in India provides equity. When a venture capitalist contributes
equity capital, he acquires the status of an owner, and becomes entitled to a
share in the firm’s profits as much as he is liable for losses.
     The advantage of the equity financing for the company seeking venture
finance is that it does not have the burden of serving the capital, as dividends
will not be paid if the company has no cash flows.
The advantage to the VCFs is that it can share in the high value of the
venture and make capital gains if the venture succeeds.


Conditional Loans:-



                                                                             21
A conditional loan is repayable in the form of a royalty after the venture
is able to generate sales. No interest is paid on such loans. In India, VCFs
charged royalty ranging between 2-15%.

Convertible Debentures & Cumulative Convertible Preference Shares:-

      Convertible Debentures and Convertible Preference Shares require an
active secondary market to be attractive securities from the investors’ point
of view.
      In the Indian context, both VCFs and entrepreneurs earlier favored a
financial package which has a higher component of loan. This was because
of the promoter’s fear of loss of ownership and control to the financier and
because of the traditional reluctance and conservation of financier to share in
the risk inherent in the use of equity.
Cumulative Convertible Preference Shares are particularly attractive in the
Indian context since CPP shareholders do not have a right to vote. They are,
however, entitled to voting if they do not receive dividend consequently for
two years.




                                                                            22
PROCESS OF VENTURE CAPITAL


 Venture capital investment activity is a sequential process involving five
steps:

1. Deal origination
2. Screening
3. Evaluation or due diligence
4. Deal structuring
5. Post-investment activities and exit




                                                                         23
POST INVESTMENT
                           ACTIVIES/ EXIT

                         DEAL STRUCTURING


                             DUE DILIGENCE



                               SCREENING



                          DEAL ORIGINATION




1. Deal origination A continuous flow of deals is essential for the venture
capital business. Deals may originate in various ways. Referral system is an
important source of deals. Deals may be referred to the VCs through their
parent organizations, trade partners, industry associations, friends etc.

     The venture capital industry in India has become quite proactive in its
approach to generating the deal flow by encouraging individuals to come up
with their business plans. Consultancy firms like Mckinsey and Arthur
Anderson have come up with business plan competitions on an all India
basis through the popular press as well as direct interaction with premier
educational and research institutions to source new and innovative ideas.
The short listed plans are provided with necessary expertise through people
who have experience in the industry.

2. Screening VCFs carry out initial screening of all projects on the basis of
some broad criteria. For example the screening process may limit projects to
areas in which the venture capitalist is familiar in terms of technology, or

                                                                          24
product, or market scope. The size of investment, geographical location and
stage of financing could also be used as the broad screening criteria.

3. Evaluation or due diligence Once a proposal has passed through initial
screening, it is subjected to a detailed evaluation or due diligence process.
Most ventures are new and the entrepreneurs may lack operating experience.
Hence a sophisticated, formal evaluation is neither possible nor desirable.

    The VCs thus rely on a subjective but comprehensive, evaluation. VCFs
evaluate the quality of the entrepreneur before appraising the characteristics
of the product, market or technology. Most venture capitalists ask for a
business plan to make an assessment of the possible risk and expected return
on the venture. Following points are taken into consideration while
performing due diligence. These include-

                • BACKROUND
                • MARKET AND COMPETITORS

                • TECHNOLOGY AND MANUFACTURING

                • MARKETING AND SALES STRATEGY

                • ORGANIZATION AND MANAGEMENT

                • FINANCE AND LEGAL ASPECT

   Investment Valuation The investment valuation process is aimed at
   ascertaiing an acceptable price for the deal. The valuation process goes
   through the following steps:

                • Projections on future revenue and profitability
                • Expected market capitalization
                • Deciding on the ownership stake based on the return
                  expected on the proposed investment

                The pricing thus calculated is rationalized after taking in to
           consideration various economic scenarios, demand and supply of
           capital, founder's/management team's track record, innovation/


                                                                              25
unique selling propositions (USPs), the product/service size of
           the potential market, etc.

4. Deal Structuring Once the venture has been evaluated as viable, the
venture capitalist and the investment company negotiate the terms of the
deal, i.e. the amount, form and price of the investment. This process is
termed as deal structuring.

       The agreement also includes the protective covenants and earn-out
arrangements. Covenants include the venture capitalists right to control the
investee company and to change its management if needed, buy back
arrangements, acquisition, making initial public offerings (IPOs) etc, Earn-
out arrangements specify the entrepreneur's equity share and the objectives
to be achieved.

    Venture capitalists generally negotiate deals to ensure protection of their
interests. They would like a deal to provide for:

                •   A return commensurate with the risk
                •   Influence over the firm through board membership
                •   Minimizing taxes
                •   Assuring investment liquidity
                •   The right to replace management in case of consistent
                    poor managerial performance.

     The investee companies would like the deal to be structured in such a
way that their interests are protected. They would like to earn reasonable
return, minimize taxes, have enough liquidity to operate their business and
remain in commanding position of their business.

      There are a number of common concerns shared by both the venture
capitalists and the investee companies. They should be flexible, and have a
structure, which protects their mutual interests and provides enough
incentives to both to cooperate with each other.

    The instruments to be used in structuring deals are many and varied. The
objective in selecting the instrument would be to maximize (or optimize)
venture capital's returns/protection and yet satisfy the entrepreneur's


                                                                            26
requirements. The different instruments through which a Venture Capitalist
could invest a company include: Equity shares, preference shares, loans,
warrants and options.

5. Post-investment Activities and Exit Once the deal has been structured
and agreement finalized, the venture capitalist generally assumes the role of
a partner and collaborator. He also gets involved in shaping of the direction
of the venture. This may be done via a formal representation of the board of
directors, or informal influence in improving the quality of marketing,
finance and other managerial functions.

    The degree of the venture capitalists involvement depends on his policy.
It may not, however, be desirable for a venture capitalist to get involved in
the day-to-day operation of the venture. If a financial or managerial crisis
occurs, the venture capitalist may intervene, and even install a new
management team.

    Venture capitalists typically aim at making medium-to long-term capital
gains. They generally want to cash-out their gains in five to ten years after
the initial investment. They play a positive role in directing the company
towards particular exit routes. A venture capitalist can exit in four ways:

                • Initial Public Offerings (IPOs)
                • Acquisition by another company
                • Repurchase of the venture capitalist ? share by the
                  investee company

    VENTURE CAPITAL SCENARIO IN INDIA
   1972: The Committee on Development of Small and Medium
   Entrepreneurs, under the chairmanship of Mr. R. S. Bhatt, first
   highlighted venture capital financing in India.

1975: venture capital financing was introduced in India by the
financial institutions with the inauguration of Risk Capital Foundation
(RCF), sponsored by IFCI with a view to encouraging technologists and
professionals to promote new industries.



                                                                          27
1976: The seed capital scheme was introduced by IDBI.

1983: The Technology Policy statement of the Government set the
guidelines for technological self-reliance by encouraging the
commercialization and exploitation of technologies developed in the
country. Till 1984 venture capital took the form of risk capital and seed
capital.

1986: ICICI launched a venture capital scheme to encourage new
technocrats in the private sector in emerging fields of high-risk technology.

1986-87: the Government levied a 5 per cent cess on all know-how
payments to create a venture capital fund by IDBI. ICICI also became a
partner of the venture capital industry in the same year.

1988-89:

                • The first attempt to frame comprehensive guidelines
                  governing venture capital funds was. Even under these
                  guidelines, only all India financial institutions, all
                  scheduled banks including foreign banks operating in
                  India, and the subsidiaries of the above were eligible to
                  set up venture capital funds/companies.
                • IFCI sponsored RCF was converted into the Risk Capital
                  and Technology Finance Corporation of India Ltd.

                • Unit Trust of India sponsored venture capital unit
                  schemes. State Bank of India has a venture capital
                  scheme operated through its subsidiary SBI Caps.

                • ICICI flagged off a new venture capital company called
                  Technology Development and Information Company of
                  India with the objective of encouraging new technocrats
                  in the private sector in high-risk areas.

                • The first scheme floated by Canara Bank had
                  participation by World Bank. About the same time, two
                  State level corporations, viz., Andhra Pradesh and


                                                                            28
Gujarat also took initiatives to promote venture capital
                   funds and could obtain World Bank assistance. A foreign
                   bank set up a Venture Capital Fund in 1987. In addition,
                   other public sector banks have participated in the equity
                   share capital of venture capital companies or invested in
                   schemes of venture capital funds.

       Several venture capital firms are incorporated in India and they are
promoted either by financial institutions, such as IDBI, ICICI, IFCI, State-
level financial institutions and public sector banks, or promoted by foreign
banks/private sector financial institutions such as Indus Venture Capital
Fund, Credit Capital Venture Fund, and so on. Hence, the total pool of
Indian venture capital today stands over Rs 5,000 crore.

     VENTURE capital, the new-age finance, is gaining importance in the
Indian economy as traditional financial institutions and commercial banks
are hamstrung by inadequacy of equity capital, focus on low-risk ventures,
conservative approach, and delays in project evaluation.

    Venture capital is also often described as "the early stage financing of
new and young enterprises seeking to grow rapidly".




                                                                          29
From the above table we can see that venture capital is continuously
growing in INDIA.


    The venture capital sector in India is still at the crossroads and striving
hard to take off. In the recent past, many changes have been occurred in the
industry. They are:

                • Capital is pouring into private equity funds;
                • Average ticket size of VC investment is increasing;
                • First-generation entrepreneurs are finding it easier to
                  raise funds;
                • Investors are demanding non-financial value addition;
                • Most States are setting up regional VC funds;
                • VC firms are getting professionalised;
                • Incubation of entrepreneurs is increasing;
                • VC firms are acquiring specific industry focus; and
                • Competition is stretching valuations.

     The industry can well leap into the high growth trajectory if it is given
the necessary boost and the Government and the venture capitalists take the
proper measures.

       Unless the challenges facing the sector are rightly addressed, VC
funding cannot meet with the kind of success it has in the developed
countries.

TRENDS OF VENTURE CAPITAL IN INDIA

2007 – PE/VC Trends

             • 31% of all investments fell into the US$10-25
million category

             • capital investments accounted for 25%


                                                                             30
of the private equity deals (in volume terms).

            • Late stage deals accounted for 35% of all deals
PE firms obtained exit routes in 65 companies,
including 16 via initial public offering (IPO)

              • While companies based in South India attracted a
higher number of investments, their peers in Western
India attracted a far higher share of the pie in value terms.
              • Among cities, Mumbai-based companies retained the
top slot with 108 private equity investments worth
almost US$6 billion in 2007, followed by Delhi/National
Capital Region with 63 investments worth almost
US$2.7 billion and Bangalore with 49 investments worth
US$700 million.

            • Citigroup was the most active investor, with a portfolio
across energy, engineering & construction,
manufacturing. Other active investors include: ICICI
Ventures, Goldman Sachs and Helion Ventures

 Top Cities attracting PE Investments
(2007)
City                         No. of Deals                    Value(US$M)
MUMBAI                       109                              5995
Delhi/NCR*                    63                              2688
BANGALORE                     49                              685
CHENNAI                      32                               824
AHMEDABAD                    14                               492
KOLKATA                      12                              339
HYDERABAD                    41                              1380

PHASES

PHASE I –
 Formation of TDICI in the 80’s and regional
funds as GVFL & APIDC in the early 90s.


                                                                         31
PHASE II-
 Entry of Foreign Venture Capital funds
(VCF) between 1995-1999

PHASE III-
 (2000 onwards). Emergence of successful
Setting the stage - Venture Capital in India
India-centric VC firms.


PHASE IV –
(current) Global VCs and PE firms actively
investing in India.
 300 Funds active in the last 3 years (Government,
              Overseas, Corporate, Domestic)




                  SECTORS OF INTEREST
Sectors of interest




                                                     32
IT & ITES companies continue to corner the majority share of VC
investments - accounting for about 70% in terms of number of investments.
Within IT & ITES, vertically focused BPO companies have emerged as the
favorite sector in 2007, followed by Internet-based Services (the 2006
favorite), IT                                                   Services
and Mobile                                                      Value-
Added                                                           Services
(M-VAS).

However,                                                        gone are
the       days                                                  when
Venture                                                         Capital
was
something                                                       that was
meant only                                                      for IT &
ITES
companies.                                                      Within
the
Healthcare & Life Sciences industry for example, Clinical Research
Outsourcing (CRO) and Biotech companies are attracting the attention of
both specialist VC firms as well as sector-agnostic firms.




                                                                         33
Especially interesting to VCs are sectors that tap the rising consumer
spending in India. While means that they are more than willing to listen to
pitches from start-ups in sectors like Media, Financial Services, Food &
Beverages and Retail.

Hands on experience

    The series of delegations of US VCs that The Indus Entrepreneurs (TiE)
                                                 and Silicon Valley Bank
                                                 led in the years preceding
                                                 2006 played an important
                                                 role    in   exposing      and
                                                 encouraging            Silicon
                                                 Valley VCs like KPCB,
                                                 Battery Ventures, Canaan
                                                 Partners, Greylock and
                                                 Matrix Partners India to
                                                 make direct investments
                                                 in     Indian     companies.
                                                 Sequoia         Capital,    of
course, has joined hands with Bangalore-based WestBridge Capital to create
a series of India-dedicated funds for investments across various stages of
company development.

      Other VC funds with strong Silicon Valley connections - including
Helion Ventures, Nexus India Capital and IDG Ventures India -also
launched their funds in 2006 and are actively investing now. These VCs also
have willing co-investors among strategic investors like Intel Capital and
Cisco Systems who have dedicated professionals on the ground in India.



                                                                             34
One of the key differentiators among the new breed of VCs is that they
include successful entrepreneurs - like Sanjeev Aggarwal and Ashish Gupta
of Helion Ventures, Alok Mittal of Canaan Partners and Avnish Bajaj of
Matrix Partners - among their investing teams. These VCs - who can truly
claim to have "been there and done that" (in several cases in the Indian
context as well) - can walk the talk in terms of "adding value beyond the
money".

CERTAIN OTHER FACTS:

            • High Growth in Technology and Knowledge based
              Industries (KBI)

            • KBI growing fast and mostly global, less affected by
              domestic issues.

            • Several emerging centers of innovation – biotech,
              wireless, IT, semiconductor, pharmaceutical.

            • Ability to build market leading companies in India thatserve
              both global and domestic markets.

            • India moving beyond supplier of low-cost services to
              higher-value products.

            • Quality of entrepreneurship on ascending curve.




                                                                        35
ISSUES FACED BY VENTURE
                       CAPITALISTS IN INDIA

1. Benefits on total income are currently available to domestic venture
capital funds under Section 10 (23) F of the Income Tax Act. As it presently
stands, the Act requires that investments are made by Venture Capital Funds
only in equity instruments, which imposes avoidable constraints.

   SEBI, which regulates venture capital funds permits investment in equity
and equity like instruments. All over the world, instruments such as
convertible preference shares, fully and partly convertible debentures are
used for financing by venture capital companies.

2. According to the Indian Venture Capital Association, there is no
regulatory framework for structuring the funds. Most of the domestic funds
have been set up under the Indian Trust Act 1882. While domestic funds are
required to follow SEBI guidelines, offshore funds are required to follow
RBI guidelines.

3. There is an anomaly in the tax treatment between domestic and offshore
funds. Offshore funds are generally registered in Mauritius and do not pay
any tax whereas domestic funds have to pay maximum marginal tax.

      Even among domestic funds, funds settled by Unit Trust of India are
totally exempt from tax. The contention is that offshore funds which invest
only in large industries are exempt from tax whereas domestic funds that
invest in small and medium industry are taxed.

4. Again, the provisions of Section 10 (23) F restrict venture capital
companies from investing in the services sector barring computer.

5. There is a strong opinion that telecommunication and related services,
computer hardware related services, project consultancy, design and testing
services, tourism related services and health related services should qualify
for exemption under the Act for venture capital investment.




                                                                          36
6.There is also a view that greater flexibility should be made available to
venture capital investments in unlisted securities. Interestingly, even foreign
institutional investors are permitted to invest in unlisted debt instruments.




                                                                            37
WEBLIOGRAPHY / BIBLIOGRAPHY


WEBLIOGRAPHY
www.google.co.in

wikipedia.org/wiki/Silicon_Valley

www.netvalley.com/svhistory.html

www.altassets.net/hm_glossary.php

www.vccircle.com

www.siliconvalley.com/ - 80k




                                       38
WEBLIOGRAPHY / BIBLIOGRAPHY


WEBLIOGRAPHY
www.google.co.in

wikipedia.org/wiki/Silicon_Valley

www.netvalley.com/svhistory.html

www.altassets.net/hm_glossary.php

www.vccircle.com

www.siliconvalley.com/ - 80k




                                       38

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Current scenario of venture capital

  • 1. CONTEMPORARY ISSUE ON SEMINAR A STUDY ON “Current scenario of Venture Capital” www.studygalaxy.com 1
  • 2. Preface The underlying aim of the seminar on contemporary issue as an integral part of MBA program is to provide the students with practical aspects of the organization – working environment. Such type of presentation helps a student to visualize and realize about the congruencies between the theoretical learning in the premises of college and actual followed by the organization. It gives the knowledge of application aspect of the theories learnt in the classroom. The seminar project in “Current scenario of Venture capital” is a complete experience in itself, which provide me with the understanding. This has become as inspirable of my knowledge of management being learned in MBA program. 2
  • 3. INDEX 1.Introduction 2.Concept of venture capital 3.History 4.Role within venture capital firm 5.Key factor of venture capital 6.Advantages of venture capital 7.Method of venture capital financing 8.Process of venture capital 9.Venture capital scenario of India 10. Sector of Interested 11. Webliography / bibliography 3
  • 4. I. INTRODUCTION VENTURE: A business project or activity specially one that involves risk. CAPITAL: Fund employed in any business activity. Most important factor of production. No economic entity can function without capital. VENTURE CAPITAL: Venture capital is a type of private equity capital typically provided by professional, outside investors to new, growth businesses VENTURE CAPITALISTS: 4
  • 5. A venture capitalist (VC) is a person who makes such investments, these include wealthy investors, investment banks, other financial institutions other partnerships. CONCEPT: vvvv VENTURE VENTURE VENTURE CAPITAL CAPITAL CAPITAL Drives new Is risky but creates People oriented industries wealth. Growth oriented Exit oriented Internationally oriented Venture capital is a means of financing fast-growing private companies. Finance may be required for: The start up, Development/ expansion, & Modernization Of a company. Growing businesses always require capital. There are a number of different ways to fund growth. These include the owner's own capital, arranging debt finance or seeking an equity partner, as is the case with venture capital. With venture capital, the venture capitalist acquires an agreed proportion of 5
  • 6. the equity of the company in return for the requisite funding. Equity finance offers the significant advantage of having no interest charges. It is patient capital that seeks a return through long-term capital gain rather than immediate and regular interest payments. Venture capital investors are exposed, therefore, to the risk of the company failing. As a result the venture capitalist have to invest in companies that have the ability to grow very successfully and give higher- than-average returns to compensate for the risk. Venture Capital may be a viable source of financing for a business. While they generally invest in businesses that are more established and ongoing, some do fund start-ups. In general they tend to invest in high- technology businesses such as research and development, electronics and computers. Venture Capitalists deal more in large sums of money, numbering into the millions of dollars, so they are generally well suited to businesses that are going grand from the start or have grown and require gigantic expansion TASKS OF VENTURE CAPITALISTS: When venture capitalists invest in a business they : • Become part-owners and typically require a seat on the company's board of directors. • They tend to take a minority share in the company and usually do not take day-to-day control. • Professional venture capitalists act as mentors and aim to provide support and advice on a range of management and technical issues. • Assist the company to develop its full potential. The management support is the most important contribution of a venture capitalist. There are many 6
  • 7. sources of capital, but only a venture capitalist can provide experienced management input gained by helping many other companies successfully conquer the inevitable problems and growing pains. 7
  • 8. HISTORY Beginnings of modern venture capital: The earliest origins of venture capital can be traced back to the medieval Islamic mudaraba partnership. In terms of protecting the entrepreneur, sharing the risks, losses and profits the two systems of finance are remarkably similar. General Georges Doriot is considered to be the father of the modern venture capital industry. • In 1946, Doriot co-founded American Research and Development Corporation (AR&DC) with Ralph Flanders, Karl Compton and others, the biggest success of which was Digital Equipment Corporation. 8
  • 9. • When Digital Equipment went public in 1968 it provided AR&DC with 101% annualized Return on Investment (ROI). AR&DC’s $70,000 USD investment in Digital Corporation in 1957 grew in value to $355 million USD. • It is commonly accepted that the first venture-backed startup is Fairchild Semiconductor, funded in 1959 by Venrock Associates. Venture capital investments, before World War II, were primarily the sphere of influence of wealthy individuals and families. • Small Business Administration 1958. One of the first steps toward a professionally-managed venture capital industry was the passage of the Small Business Investment Act of 1958. The 1958 Act officially allowed the U.S. Small Business Administration (SBA) to license private "Small Business Investment Companies" (SBICs) to help the financing and management of the small entrepreneurial businesses in the United States. Passage of the Act addressed concerns raised in a Federal Reserve Board report to Congress that concluded that a major gap existed in the capital markets for long-term funding for growth-oriented small businesses. Facilitating the flow of capital through the economy up to the pioneering small concerns in order to stimulate the U.S. economy was and still is the main goal of the SBIC program today. Generally, venture capital is closely associated with technologically innovative ventures and mostly in the United States. Due to structural restrictions imposed on American banks in the 1930s there was no private merchant banking industry in the United States, a situation that was quite exceptional in developed nations. As late as the 1980s Lester Thurow, a noted economist, decried the inability of the USA's financial regulation framework to support any merchant bank other than one that is run by the United States Congress in the form of federally funded projects. These, he argued, were massive in scale, but also politically motivated, too focused on defense, housing and 9
  • 10. such specialized technologies as space exploration, agriculture, and aerospace. US investment banks were confined to handling large M&A transactions, the issue of equity and debt securities, and, often, the breakup of industrial concerns to access their pension fund surplus or sell off infrastructural capital for big gains. Not only was the lax regulation of this situation very heavily criticized at the time, this industrial policy differed from that of other industrialized rivals—notably Germany and Japan—which at that time were gaining ground in automotive and consumer electronics markets globally. However, those nations were also becoming somewhat more dependent on central bank and elite academic judgment, rather than the more diffuse way that priorities were set by government and private investors in the United States. 10
  • 11. THE GROWTH OF SILICON VALLEY Slow Growth in 1960s & early 1970s, and the First Boom Year in 1978: During the 1960s and 1970s, venture capital firms focused their investment activity primarily on starting and expanding companies. More often than not, these companies were exploiting breakthroughs in electronic, medical or data-processing technology. As a result, venture capital came to be almost synonymous with technology finance. Venture capital firms suffered a temporary downturn in 1974, when the stock market crashed and investors were naturally wary of this new kind of investment fund.1978 was the first big year for venture capital. The industry raised approximately $750,000 in 1978. 11
  • 12. Highs & Lows of the 1980s: In 1978, the US Labor Department reinterpreted ERISA legislation and thus enabled this major pool of pension fund money to invest in alternative assets classes such as venture capital firms. Venture capital financing took off. 1983 was the boom year - the stock market went through the roof and there were over 100 initial public offerings for the first time in U.S. history. That year was also the year that many of today's largest and most prominent VC firms were founded. Due to the excess of IPOs and the inexperience of many venture capital fund managers, VC returns were very low through the 1980s. VC firms retrenched, working hard to make their portfolio companies successful. The work paid off and returns began climbing back up. The dot com boom: The late 1990s were a boom time for the globally-renowned VC firms on Sand Hill Road in the San Francisco Bay Area. A number of large IPOs had taken place, and access to "friends and family" shares was becoming a major determiner of who would benefit from any such Common investors would have had no chance to invest at the strike price in this stage. The NASDAQ crash and technology slump that started in March 2000 shook some VC funds significantly by the resulting disastrous losses from overvalued and non-performing startups. By 2003 many firms were forced to write off companies they had funded just a few years earlier, and many funds were found "under water";( the market value of their portfolio companies were less than the invested value). Venture capital investors sought to reduce the large commitments they had made to venture capital funds. By mid-2003, the venture capital industry would shrivel to about half its 2001 capacity. Nevertheless, PricewaterhouseCoopers' MoneyTree Survey shows that total venture capital investments hold steady at 2003 levels through the second quarter of 2005. The revival of an Internet-driven environment 12
  • 13. (thanks to deals such as eBay's purchase of Skype, the News Corporation's purchase of MySpace.com, and the very successful Google.com and Salesforce.com IPOs) have helped to revive the VC environment. ROLES WITHIN A VENTURE CAPITAL FIRM 1. Venture capital general partners: (Also known in this case as "venture capitalists" or "VCs") are the executives in the firm. In other words the investment professionals. Typical career backgrounds vary, but VCs come from either an operational or a finance background. VCs with an operational background tend to be former chief executives at firms similar to those which the partnership finances and other senior executives in technology companies.VCs with finance backgrounds come from investment banks, M&A firms, and other firms in the corporate investment and finance space. 2. Limited partners: Investors in venture capital funds are known as limited partners. This constituency comprises both high net worth individuals and institutions with large amounts of available capital, such as state and private pension funds, insurance companies, and pooled investment vehicles, called fund of funds or mutual funds. 3. Venture partners and entrepreneur-in-residence (EIR): Other positions at venture capital firms include venture partners and entrepreneur-in-residence (EIR).Venture partners "bring in deals" and receive income only on deals they work on (as opposed to general partners who receive income on all deals). EIRs are experts in a particular domain and perform due diligence on potential deals. EIRs are engaged by VC firms temporarily (six to 18 months) and are expected to develop and pitch startup ideas to their host firm (although neither party is bound to work with each other). Some EIR's 13
  • 14. move on to roles such as Chief Technology Officer (CTO) at a portfolio company. 4. Associate: The "associate" is the typical apprentice within a venture capital firm. After a few successful years, an associate may move up to the "senior associate" position. The next step from senior associate is "principal," typically a partner track position. Alternatively, there are many pre-MBA associate roles that are used solely for the purpose of deal sourcing, and the associate is usually expected to move on after two years. STRATEGIC ROLES Serving Board Business Consultant Financier SOCIAL/ SUPPORTIVE • Coach/ Mentor • Conflict resolver . NETWORKING ROLES • Management recruiter • Professional contact • Industrial contact 14
  • 15. FEATURES OF VENTURE CAPITAL The main features of venture capital are: Long-time horizon: In general, venture capital undertakings take a longer time — say, 5-10 years at a minimum — to come out commercially successful; one should, thus, be able to wait patiently for the outcome of the venture. Lack of liquidity: Since the project is expected to run at start-up stage for several years, liquidity may be a greater problem. High risk: The risk of the project is associated with management, product and operations. Unlike other projects, the ones that run under the venture finance may be subject to a higher degree of risk, as their result is uncertain or, at best, probable in nature. High-tech: Venture capital finance caters largely to the needs of first- generation entrepreneurs who are technocrats, with innovative technological business ideas that have not so far been tapped in the industrial field. However, a venture capitalist looks not only for high-technology but the innovativeness through which the project can succeed. Equity participation and capital gains: A venture capitalist invests his money in terms of equity or quasi-equity. He does not look for any dividend or other benefits, but when the project commercially succeeds, then he can 15
  • 16. enjoy the capital gain which is his main benefit. Otherwise, he will be losing his entire investment. Participation in management: Unlike the traditional financier or banker, the venture capitalist can provide managerial expertise to entrepreneurs besides money. Since many innovations and inventions cannot be commercialized due to lack of finance, venture capital finance acts as a strong impetus for entrepreneurs to develop products involving newer technologies and to commercialize them. Venture capital has also gained in importance as a mechanism for the rehabilitation of sick companies. Moreover, venture capitalists also assist smaller units in upgrading their technology. KEY FACTORS FOR THE SUCCESS: The key factors for the success of any project under the consideration of a venture capitalist are: • Clear and objective thinking; • Operational experience, especially in a start-up; • Firm grasp of numbers of numbers; • People management skills; • Ability to spot technology and market trends; • Wide network of contacts; • Knowledge of all facets of business — marketing, Finance and HR; • Judgment to evaluate them on the basis of integrity and ability; • Patience to pursue the final goal; • Drive to guide budding entrepreneurs; and 16
  • 17. • Empathy with entrepreneurs. PATIENCE CLEAR OBJECTIVE NETWORK SUCCESS EXPERIE NCE DRIVE MANAGEME NT SKILLS 17
  • 18. ADVANTAGES OF VENTURE CAPITAL Venture capital has made significant contribution to technological innovations and promotion of entrepreneurism. Many of the companies like Apple, Lotus, Intel, Micro etc. have emerged from small business set up by people with ideas but no financial resources and supported by venture capital. There are abundant benefits to economy, investors and entrepreneurs provided by venture capital. Economy Oriented- • Helps in industrialization of the country • Helps in the technological development of the country • Generates employment • Helps in developing entrepreneurial skills Investor oriented- • Benefit to the investor is that they are invited to invest only after company starts earning profit, so the risk is less and healthy growth of capital market is entrusted. • Profit to venture capital companies. • Helps them to employ their idle funds into productive avenues. Entrepreneur oriented: • Finance - The venture capitalist injects long-term equity finance, which provides a solid capital base for future growth. The venture capitalist may also be capable of providing additional rounds of funding should it be required to finance growth. 18
  • 19. • Business Partner - The venture capitalist is a business partner, sharing the risks and rewards. Venture capitalists are rewarded by business success and the capital gain. • Mentoring - The venture capitalist is able to provide strategic, operational and financial advice to the company based on past experience with other companies in similar situations. • Alliances - The venture capitalist also has a network of contacts in many areas that can add value to the company, such as in recruiting key personnel, providing contacts in international markets, introductions to strategic partners and, if needed, co-investments with other venture capital firms when additional rounds of financing are required. • Facilitation of Exit - The venture capitalist is experienced in the process of preparing a company for an initial public offering (IPO) and facilitating in trade sales. ADVANTAGES ENTREPRENEUR ECONOMY INVESTOR ORIENTED 19
  • 20. WHAT DO VENTURE CAPITALISTS LOOK FOR WHILE INVESTING? 1. A GROWING MARKET: The venture capitalists see whether the company is targeting a substantial and rapidly growing market. Does the company have a reasonable chance to successfully enter the market and obtain a strong market position? 2. A UNIQUE PRODUCT: Is the company having a proprietary or differentiated product? Does the product offer benefits over existing products? Does it have patent or other proprietary protection to forestall competitors? 3. IPO CANDIDATE OR ACQUISITION TARGET: Whether the company has the possibility of growing quickly and becoming an attractive acquisition target or IPO candidate? Venture capitalists are concerned about how they will realize liquidity and receive value for their investment. 4. SOUND BUSINESS PLAN: Is the company's strategy and business plan sound? Venture capitalists expect to see a well-thought-out, coherent business plan. 5. SIGNIFICANT GROSS PROFIT MARGINS: Can the product or service generate significant gross profit margins (40 percent or more)? Large profit margins give a company room for error and enhance its attractiveness for a possible IPO or acquisition. 6. HOME RUN POTENTIAL: Finally, the venture capitalist wants to see the possibility of hitting a "home run" by investing in the company. Most 20
  • 21. venture capitalists won't be interested unless the company can grow to at least $25 million in sales within five years. . METHODS OF VENTURE FINANCING A pre-requisite for the development of an active venture capital industry is the availability of a variety of financial instruments which cater to the different risk-return needs of investors. They should be acceptable to entrepreneurs as well. Venture capital financing in India took four forms:- • Equity • Conditional Loan • Convertible Debentures • Cumulative Convertible Preference Share Equity:- All VCFs in India provides equity. When a venture capitalist contributes equity capital, he acquires the status of an owner, and becomes entitled to a share in the firm’s profits as much as he is liable for losses. The advantage of the equity financing for the company seeking venture finance is that it does not have the burden of serving the capital, as dividends will not be paid if the company has no cash flows. The advantage to the VCFs is that it can share in the high value of the venture and make capital gains if the venture succeeds. Conditional Loans:- 21
  • 22. A conditional loan is repayable in the form of a royalty after the venture is able to generate sales. No interest is paid on such loans. In India, VCFs charged royalty ranging between 2-15%. Convertible Debentures & Cumulative Convertible Preference Shares:- Convertible Debentures and Convertible Preference Shares require an active secondary market to be attractive securities from the investors’ point of view. In the Indian context, both VCFs and entrepreneurs earlier favored a financial package which has a higher component of loan. This was because of the promoter’s fear of loss of ownership and control to the financier and because of the traditional reluctance and conservation of financier to share in the risk inherent in the use of equity. Cumulative Convertible Preference Shares are particularly attractive in the Indian context since CPP shareholders do not have a right to vote. They are, however, entitled to voting if they do not receive dividend consequently for two years. 22
  • 23. PROCESS OF VENTURE CAPITAL Venture capital investment activity is a sequential process involving five steps: 1. Deal origination 2. Screening 3. Evaluation or due diligence 4. Deal structuring 5. Post-investment activities and exit 23
  • 24. POST INVESTMENT ACTIVIES/ EXIT DEAL STRUCTURING DUE DILIGENCE SCREENING DEAL ORIGINATION 1. Deal origination A continuous flow of deals is essential for the venture capital business. Deals may originate in various ways. Referral system is an important source of deals. Deals may be referred to the VCs through their parent organizations, trade partners, industry associations, friends etc. The venture capital industry in India has become quite proactive in its approach to generating the deal flow by encouraging individuals to come up with their business plans. Consultancy firms like Mckinsey and Arthur Anderson have come up with business plan competitions on an all India basis through the popular press as well as direct interaction with premier educational and research institutions to source new and innovative ideas. The short listed plans are provided with necessary expertise through people who have experience in the industry. 2. Screening VCFs carry out initial screening of all projects on the basis of some broad criteria. For example the screening process may limit projects to areas in which the venture capitalist is familiar in terms of technology, or 24
  • 25. product, or market scope. The size of investment, geographical location and stage of financing could also be used as the broad screening criteria. 3. Evaluation or due diligence Once a proposal has passed through initial screening, it is subjected to a detailed evaluation or due diligence process. Most ventures are new and the entrepreneurs may lack operating experience. Hence a sophisticated, formal evaluation is neither possible nor desirable. The VCs thus rely on a subjective but comprehensive, evaluation. VCFs evaluate the quality of the entrepreneur before appraising the characteristics of the product, market or technology. Most venture capitalists ask for a business plan to make an assessment of the possible risk and expected return on the venture. Following points are taken into consideration while performing due diligence. These include- • BACKROUND • MARKET AND COMPETITORS • TECHNOLOGY AND MANUFACTURING • MARKETING AND SALES STRATEGY • ORGANIZATION AND MANAGEMENT • FINANCE AND LEGAL ASPECT Investment Valuation The investment valuation process is aimed at ascertaiing an acceptable price for the deal. The valuation process goes through the following steps: • Projections on future revenue and profitability • Expected market capitalization • Deciding on the ownership stake based on the return expected on the proposed investment The pricing thus calculated is rationalized after taking in to consideration various economic scenarios, demand and supply of capital, founder's/management team's track record, innovation/ 25
  • 26. unique selling propositions (USPs), the product/service size of the potential market, etc. 4. Deal Structuring Once the venture has been evaluated as viable, the venture capitalist and the investment company negotiate the terms of the deal, i.e. the amount, form and price of the investment. This process is termed as deal structuring. The agreement also includes the protective covenants and earn-out arrangements. Covenants include the venture capitalists right to control the investee company and to change its management if needed, buy back arrangements, acquisition, making initial public offerings (IPOs) etc, Earn- out arrangements specify the entrepreneur's equity share and the objectives to be achieved. Venture capitalists generally negotiate deals to ensure protection of their interests. They would like a deal to provide for: • A return commensurate with the risk • Influence over the firm through board membership • Minimizing taxes • Assuring investment liquidity • The right to replace management in case of consistent poor managerial performance. The investee companies would like the deal to be structured in such a way that their interests are protected. They would like to earn reasonable return, minimize taxes, have enough liquidity to operate their business and remain in commanding position of their business. There are a number of common concerns shared by both the venture capitalists and the investee companies. They should be flexible, and have a structure, which protects their mutual interests and provides enough incentives to both to cooperate with each other. The instruments to be used in structuring deals are many and varied. The objective in selecting the instrument would be to maximize (or optimize) venture capital's returns/protection and yet satisfy the entrepreneur's 26
  • 27. requirements. The different instruments through which a Venture Capitalist could invest a company include: Equity shares, preference shares, loans, warrants and options. 5. Post-investment Activities and Exit Once the deal has been structured and agreement finalized, the venture capitalist generally assumes the role of a partner and collaborator. He also gets involved in shaping of the direction of the venture. This may be done via a formal representation of the board of directors, or informal influence in improving the quality of marketing, finance and other managerial functions. The degree of the venture capitalists involvement depends on his policy. It may not, however, be desirable for a venture capitalist to get involved in the day-to-day operation of the venture. If a financial or managerial crisis occurs, the venture capitalist may intervene, and even install a new management team. Venture capitalists typically aim at making medium-to long-term capital gains. They generally want to cash-out their gains in five to ten years after the initial investment. They play a positive role in directing the company towards particular exit routes. A venture capitalist can exit in four ways: • Initial Public Offerings (IPOs) • Acquisition by another company • Repurchase of the venture capitalist ? share by the investee company VENTURE CAPITAL SCENARIO IN INDIA 1972: The Committee on Development of Small and Medium Entrepreneurs, under the chairmanship of Mr. R. S. Bhatt, first highlighted venture capital financing in India. 1975: venture capital financing was introduced in India by the financial institutions with the inauguration of Risk Capital Foundation (RCF), sponsored by IFCI with a view to encouraging technologists and professionals to promote new industries. 27
  • 28. 1976: The seed capital scheme was introduced by IDBI. 1983: The Technology Policy statement of the Government set the guidelines for technological self-reliance by encouraging the commercialization and exploitation of technologies developed in the country. Till 1984 venture capital took the form of risk capital and seed capital. 1986: ICICI launched a venture capital scheme to encourage new technocrats in the private sector in emerging fields of high-risk technology. 1986-87: the Government levied a 5 per cent cess on all know-how payments to create a venture capital fund by IDBI. ICICI also became a partner of the venture capital industry in the same year. 1988-89: • The first attempt to frame comprehensive guidelines governing venture capital funds was. Even under these guidelines, only all India financial institutions, all scheduled banks including foreign banks operating in India, and the subsidiaries of the above were eligible to set up venture capital funds/companies. • IFCI sponsored RCF was converted into the Risk Capital and Technology Finance Corporation of India Ltd. • Unit Trust of India sponsored venture capital unit schemes. State Bank of India has a venture capital scheme operated through its subsidiary SBI Caps. • ICICI flagged off a new venture capital company called Technology Development and Information Company of India with the objective of encouraging new technocrats in the private sector in high-risk areas. • The first scheme floated by Canara Bank had participation by World Bank. About the same time, two State level corporations, viz., Andhra Pradesh and 28
  • 29. Gujarat also took initiatives to promote venture capital funds and could obtain World Bank assistance. A foreign bank set up a Venture Capital Fund in 1987. In addition, other public sector banks have participated in the equity share capital of venture capital companies or invested in schemes of venture capital funds. Several venture capital firms are incorporated in India and they are promoted either by financial institutions, such as IDBI, ICICI, IFCI, State- level financial institutions and public sector banks, or promoted by foreign banks/private sector financial institutions such as Indus Venture Capital Fund, Credit Capital Venture Fund, and so on. Hence, the total pool of Indian venture capital today stands over Rs 5,000 crore. VENTURE capital, the new-age finance, is gaining importance in the Indian economy as traditional financial institutions and commercial banks are hamstrung by inadequacy of equity capital, focus on low-risk ventures, conservative approach, and delays in project evaluation. Venture capital is also often described as "the early stage financing of new and young enterprises seeking to grow rapidly". 29
  • 30. From the above table we can see that venture capital is continuously growing in INDIA. The venture capital sector in India is still at the crossroads and striving hard to take off. In the recent past, many changes have been occurred in the industry. They are: • Capital is pouring into private equity funds; • Average ticket size of VC investment is increasing; • First-generation entrepreneurs are finding it easier to raise funds; • Investors are demanding non-financial value addition; • Most States are setting up regional VC funds; • VC firms are getting professionalised; • Incubation of entrepreneurs is increasing; • VC firms are acquiring specific industry focus; and • Competition is stretching valuations. The industry can well leap into the high growth trajectory if it is given the necessary boost and the Government and the venture capitalists take the proper measures. Unless the challenges facing the sector are rightly addressed, VC funding cannot meet with the kind of success it has in the developed countries. TRENDS OF VENTURE CAPITAL IN INDIA 2007 – PE/VC Trends • 31% of all investments fell into the US$10-25 million category • capital investments accounted for 25% 30
  • 31. of the private equity deals (in volume terms). • Late stage deals accounted for 35% of all deals PE firms obtained exit routes in 65 companies, including 16 via initial public offering (IPO) • While companies based in South India attracted a higher number of investments, their peers in Western India attracted a far higher share of the pie in value terms. • Among cities, Mumbai-based companies retained the top slot with 108 private equity investments worth almost US$6 billion in 2007, followed by Delhi/National Capital Region with 63 investments worth almost US$2.7 billion and Bangalore with 49 investments worth US$700 million. • Citigroup was the most active investor, with a portfolio across energy, engineering & construction, manufacturing. Other active investors include: ICICI Ventures, Goldman Sachs and Helion Ventures Top Cities attracting PE Investments (2007) City No. of Deals Value(US$M) MUMBAI 109 5995 Delhi/NCR* 63 2688 BANGALORE 49 685 CHENNAI 32 824 AHMEDABAD 14 492 KOLKATA 12 339 HYDERABAD 41 1380 PHASES PHASE I – Formation of TDICI in the 80’s and regional funds as GVFL & APIDC in the early 90s. 31
  • 32. PHASE II- Entry of Foreign Venture Capital funds (VCF) between 1995-1999 PHASE III- (2000 onwards). Emergence of successful Setting the stage - Venture Capital in India India-centric VC firms. PHASE IV – (current) Global VCs and PE firms actively investing in India. 300 Funds active in the last 3 years (Government, Overseas, Corporate, Domestic) SECTORS OF INTEREST Sectors of interest 32
  • 33. IT & ITES companies continue to corner the majority share of VC investments - accounting for about 70% in terms of number of investments. Within IT & ITES, vertically focused BPO companies have emerged as the favorite sector in 2007, followed by Internet-based Services (the 2006 favorite), IT Services and Mobile Value- Added Services (M-VAS). However, gone are the days when Venture Capital was something that was meant only for IT & ITES companies. Within the Healthcare & Life Sciences industry for example, Clinical Research Outsourcing (CRO) and Biotech companies are attracting the attention of both specialist VC firms as well as sector-agnostic firms. 33
  • 34. Especially interesting to VCs are sectors that tap the rising consumer spending in India. While means that they are more than willing to listen to pitches from start-ups in sectors like Media, Financial Services, Food & Beverages and Retail. Hands on experience The series of delegations of US VCs that The Indus Entrepreneurs (TiE) and Silicon Valley Bank led in the years preceding 2006 played an important role in exposing and encouraging Silicon Valley VCs like KPCB, Battery Ventures, Canaan Partners, Greylock and Matrix Partners India to make direct investments in Indian companies. Sequoia Capital, of course, has joined hands with Bangalore-based WestBridge Capital to create a series of India-dedicated funds for investments across various stages of company development. Other VC funds with strong Silicon Valley connections - including Helion Ventures, Nexus India Capital and IDG Ventures India -also launched their funds in 2006 and are actively investing now. These VCs also have willing co-investors among strategic investors like Intel Capital and Cisco Systems who have dedicated professionals on the ground in India. 34
  • 35. One of the key differentiators among the new breed of VCs is that they include successful entrepreneurs - like Sanjeev Aggarwal and Ashish Gupta of Helion Ventures, Alok Mittal of Canaan Partners and Avnish Bajaj of Matrix Partners - among their investing teams. These VCs - who can truly claim to have "been there and done that" (in several cases in the Indian context as well) - can walk the talk in terms of "adding value beyond the money". CERTAIN OTHER FACTS: • High Growth in Technology and Knowledge based Industries (KBI) • KBI growing fast and mostly global, less affected by domestic issues. • Several emerging centers of innovation – biotech, wireless, IT, semiconductor, pharmaceutical. • Ability to build market leading companies in India thatserve both global and domestic markets. • India moving beyond supplier of low-cost services to higher-value products. • Quality of entrepreneurship on ascending curve. 35
  • 36. ISSUES FACED BY VENTURE CAPITALISTS IN INDIA 1. Benefits on total income are currently available to domestic venture capital funds under Section 10 (23) F of the Income Tax Act. As it presently stands, the Act requires that investments are made by Venture Capital Funds only in equity instruments, which imposes avoidable constraints. SEBI, which regulates venture capital funds permits investment in equity and equity like instruments. All over the world, instruments such as convertible preference shares, fully and partly convertible debentures are used for financing by venture capital companies. 2. According to the Indian Venture Capital Association, there is no regulatory framework for structuring the funds. Most of the domestic funds have been set up under the Indian Trust Act 1882. While domestic funds are required to follow SEBI guidelines, offshore funds are required to follow RBI guidelines. 3. There is an anomaly in the tax treatment between domestic and offshore funds. Offshore funds are generally registered in Mauritius and do not pay any tax whereas domestic funds have to pay maximum marginal tax. Even among domestic funds, funds settled by Unit Trust of India are totally exempt from tax. The contention is that offshore funds which invest only in large industries are exempt from tax whereas domestic funds that invest in small and medium industry are taxed. 4. Again, the provisions of Section 10 (23) F restrict venture capital companies from investing in the services sector barring computer. 5. There is a strong opinion that telecommunication and related services, computer hardware related services, project consultancy, design and testing services, tourism related services and health related services should qualify for exemption under the Act for venture capital investment. 36
  • 37. 6.There is also a view that greater flexibility should be made available to venture capital investments in unlisted securities. Interestingly, even foreign institutional investors are permitted to invest in unlisted debt instruments. 37